The recent financial crisis has heightened attention to the links between the financial systems and the real economy. Policy makers, especially in developing countries, have expressed a greater degree of interest in the design, development, and implementation of national strategies for developing the financial sector. Equally, policy makers have increased their investment in reporting on financial sector stability and are making greater efforts to link financial sector performance and risks to the real economy. Between 1996 and 2005, publishing of financial sector reports became a rapidly growing "industry," with the number of central banks issuing such reports increasing worldwide from 1 to about 50. Since 2005, this number has grown less rapidly, although it has kept increasing and has now reached about 80.

In a forthcoming publication, we assessed a sample of 78 countries on the comprehensiveness of their financial sector strategies. We did so against 10 predefined attributes that we postulated a comprehensive financial strategy should have. Broadly, these attributes concerned identification of financial development objectives, approach to managing systemic risk involved in achieving the set objectives, consideration of trade-offs between achieving development objectives and maintaining systemic risk in the financial sector at an acceptable level, and outline of implementation plans for the financial sector strategy.

We found that only 67 percent of the 78 countries had financial sector strategies with clearly identified goals and that only 27 percent had a quantifiable indicator included in their statement of objectives. Given that only 58 percent of strategies identify policy tools to support the achievement of the set goals, 42 percent of strategies rely on wishful thinking rather than on credible policy support. Overall, we find that the scope and characteristics of national strategies for the financial sector are influenced by a country's type of legal system, its level of income and macroeconomic stability, its existing financial depth and inclusion, the share of foreign ownership in its national financial sector, and its experience of past financial crises.

Significantly, we found that although many countries commit to both development and systemic risk management (55 percent) in their strategy; only 26 percent specify trade-offs between their financial development goals and management of systemic risk in their strategies. Overall, 42 percent of countries commit to both advancing financial development and managing systemic risk but do not consider any trade-offs between the two goals. Although most strategies refer to systemic risk in general terms (88 percent), many fewer documents (38 percent) refer to specific indicators of systemic risk, and only about a half (51 percent) of the strategies identify policy tools to manage that risk.

The absence of substantive discussions on risk-development trade-offs in financial sector strategies is troubling. Finance is well-known to be a double-edged sword - substantial developmental impact when it performs well and the major social costs when it does not. The double relevance of financial systems thus puts a high premium on carefully calibrated and implemented financial sector policies. Therefore, financial sector policy must account for the trade-off between the speed of financial development and the systemic risk accumulation. This trade-off is analogous to the risk-return trade-off in finance. At the national level, the financial sector strategy formulates policy for the financial sector and chooses how much speed and how much restraint to apply, and where. Overall, the strategy should set development targets that account for the associated risk and communicate the systemic risk appetite (tolerance) of the country in the financial area.

Admittedly, determining if a given financial sector strategy has adequately considered and communicated trade-offs between the speed of financial development and the degree of systemic risk associated with it-or, for that matter, gauging whether the strategy involves plans to address the trade-off-is challenging, but not impossible. To that end, we examined the strategies to see whether risk and return in development had been explicitly weighed. We noted whether strategies referred to the expectation that the financial system would work well-that is, would it allocate resources to the most productive uses and help the real economy, including individuals and firms, manage risks by enhancing productivity, boosting the poverty-reduction effects of growth, and promoting equal opportunity? We then looked to see whether the strategies also referred to concerns that overambitious development, excessive risk taking, and malfunctioning risk management on the side of the financial system and its clients could create a breeding ground for costly financial crises.

In general, we found that strategies include a lot of numerical analysis on recent trends and changes in the financial sector; however, they lack a comprehensive discussion of trade-offs in general and of the trade-off between financial development and systemic risk in particular. At best, they acknowledge that economic growth is negatively affected by financial sectors that are weak or unable to provide long-term capital. This is a general reference to the performance of the sector in aggregate and not explicit reference to specific systemic risks or to trade-offs between risk and development of the sector.

Our findings are consistent with research that suggests that although the process of preparing a strategy involves a lot of scientific analysis of data, it lacks the creation of novel hypotheses and careful generation of custom-tailored tests of those hypotheses. That conventional strategies are focused on isolated issues rather than making choices, an approach that would naturally lead to a discussion of trade-offs. We support the view that many strategies are merely an aggregation of issues into an all-inclusive reform program aimed at modernizing a financial system. What is needed is a 'possibilities-based approach' that balances ambition with obstacles and risks; requiring governments to recognize that they must make choices and that each choice has consequences.

To encourage risk-development trade-offs discussions in strategy formulation discussions, we emphasize the importance of establishing a financial policy or stability committee. To set compatible and sustainable policies for the financial system, a group of policy makers and experts that understands the risk-development trade-offs in financial sector development should be established. Most important, the committee's terms of reference must explicitly encourage the discussion of choices for financial sector development. Only then will norms for discussing trade-offs between risk and development be established. Formulating financial sector strategy through such policy dialogue can improve policy coordination and produce balanced policies.

In essence, our paper calls for a more dynamic strategy design, development and implementation process than is presently found in many countries around the world.

Samuel Munzele Maimbo is an Adjunct Professor of Finance at the University of Lusaka, a Simon Industrial Fellow at the University of Manchester and a Lead Financial Sector Specialist in the European and Central Asia region of the World Bank. Prior to joining the World Bank, he was a Senior Bank Inspector at the Bank of Zambia and an auditor at Price Waterhouse. A Rhodes Scholar, Samuel obtained a PhD in Public Administration from the University of Manchester, England (2001); a MBA Degree from the University of Nottingham, England (1998); a Bachelor of Accountancy Degree from the Copperbelt University, Zambia (1994). He is also a Fellow of the Association of Chartered Certified Accountants, United Kingdom and a Fellow of the Zambia Institute of Certified Accountants.

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